Markets Are Finally Appreciating How Micron's Largest Business Has Changed

Though it took a while, markets are finally starting to realize that the DRAM industry has seen real structural changes that could make the kind of vicious boom/bust cycles found throughout its history much rarer going forward.

And while this realization has already provided a big lift to DRAM and NAND flash memory giant Micron's (MU) shares in recent weeks, there could still be room for some additional upside, given that the stock still trades for less than 6 times Micron's expected fiscal 2018 (ends in August) EPS.

Micron, which reports its February quarter results on March 22, has surged closed to 50% amid a steady drumbeat of positive news and commentary from customers, analysts and trade publications. Some notable examples:

On Feb. 20, JPMorgan's Harlan Sur hiked his Micron estimates and predicted the DRAM industry's supply/demand balance will remain favorable through 2018. While forecasting memory price declines later in the year, Sur predicted cost reductions will enable further margin growth.

On Feb. 22, HP Enterprise (HPE) CEO Antonio Neri stated on his firm's earnings call that HPE continues to "see some nominal increases" in DRAM prices, and expects such increases to continue during the remainder of 2018.

In late February, DRAMeXchange forecast DRAM average selling prices (ASPs) in early 2018, albeit at a slower clip than in 2017. 5% sequential ASP growth was forecast for Q1, and 3% growth for Q2.

On March 6, Goldman Sachs' Mark Delaney hiked his Micron target by $3 to $58, while predicting constrained DRAM supplies will lead to further price increases. As an example, he noted 32GB server DRAM modules are selling for $10 to $15 more than they did in mid-January.

On March 7, Digitimes reported "industry sources" see DRAM prices rising by 5% to 10% in the first half of 2018. Strong server/data center demand was cited.

On March 12, Mizuho's Vijay Rakesh reported Asian checks "pointed to continued strong demand and price momentum" for Micron into calendar Q2. He forecast the company, whose May quarter EPS consensus is currently at $2.59, could "guide quarterly EPS closer to ~$3." Evercore and Nomura released bullish notes the same day, with Evercore's C.J. Muse arguing Micron could earn over $13 per share in calendar 2019 and is poised to announce capital returns.

All of this fits with the subdued supply growth forecasts previously made by Micron, Samsung and SK Hynix (the DRAM industry's big-3). On its December earnings call, Micron reiterated a forecast for 20% 2018 DRAM industry bit supply growth. The following month, Samsung (SSNLF) and Hynix issued similar forecasts, with Samsung also predicting low-single digit bit growth for Q1.

Meanwhile, heavy capital spending by cloud giants continues fueling strong demand for high-margin server DRAM modules. Facebook (FB) has forecast its capex will more than double in 2018 to a range of $14 billion to $15 billion, and the likes of Alphabet/Google (GOOGL) , Amazon (AMZN) , Microsoft (MSFT) and Tencent (TCEHY) are also expected to see significant (if lower) data center capex growth.

Server DRAM sales have also gotten a boost from a pickup in long-pressured enterprise server sales, thanks to a strong Intel (INTC) Xeon CPU upgrade cycle. And the growth of memory-intensive analytics, in-memory database and high-performance computing (HPC) workloads has lifted both enterprise and cloud demand.

Graphics DRAM demand has also been strong, as gamers, cryptocurrency miners and AI researchers propel graphics card sales higher. Micron, it should be noted, has long been a major memory supplier for Nvidia-powered (NVDA) cards. Automotive DRAM shipments, boosted by the arrival of more powerful infotainment systems, is also growing nicely. Further down the line, autonomous driving systems will also be a growth driver here.

PC and smartphone DRAM demand isn't as strong, but -- with the help of continued increases in the DRAM content of the average smartphone -- isn't terrible either. Overall, if predictions of 20% 2018 bit supply growth prove accurate, odds are good that demand will once more exceed supply this year. In the absence of the arrival of a major brand-new entrant -- it's possible China could produce one in a few years' time, but not in the short-term -- the good times appear set to continue for DRAM.

In the NAND flash memory market, by contrast, there is a decent chance that prices will decline some later this year -- Apple (AAPL) , the world's biggest NAND buyer, suggested it expects as much on its Feb. 1 earnings call. Unlike the DRAM market, the NAND market hasn't consolidated around a small number of players who can collectively keep a lid on supply growth. And production ramps for high-density 3D NAND flash chips are having an impact. A recent Digitimes report pointed to a 5% to 10% Q1 sequential drop for NAND contract prices.

However, things might not be quite as bad as recently feared. Whereas Micron forecast in December that 2018 NAND bit supply would grow by a high-40s percentage, Samsung and Hynix both forecast in January that growth would be closer to 40%. In addition, ramps for 3D NAND chips featuring 64 or more layers are lowering production costs, and it's likely that lower prices will help grow solid-state drive (SSD) penetration rates within both the PC and server/storage markets.

On its December call, Micron forecast the SSD attach rate for notebooks would rise from 35% in 2017 to 75% in 2020. It also predicted the amount of flash going insider the average server would rise from 2.5TB in 2017 to above 8TB in 2021.

Regardless, even if the NAND market sees healthy pricing and margin pressure this year, it's worth keeping in mind that DRAM accounts for two-thirds of Micron's revenue, and is believed to make up an even larger percentage of its gross profit. And that at least this part of Micron's business deserves to trade at a multiple higher than 6 times fiscal 2018 EPS.

Suppose one was to value Micron's DRAM business at 10 times expected fiscal 2018 EPS (hardly an exorbitant multiple), while valuing the NAND business at a mere 5 times expected earnings due to worries about upcoming price declines. If one assumes DRAM accounts for about 75% of Micron's gross profit, this would value the DRAM business at $76 and the NAND business at $13.

That would give Micron a total value of $89 per share, 49% above current levels. And if one valued the DRAM business at a mere 8 times expected fiscal 2018 EPS, total value would still come in at $74, 24% above current levels.

These rough estimates give reasons to think Micron still has some room to run. At least as long as equity market conditions remain favorable.

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